According to them, the unwritten rule in the gilts market is that the Government never cuts interest rates just ahead of an auction of new stock - to do so is certain death to market-makers since invariably they prepare themselves for an auction by going short of stock. If interest rates are cut just ahead of the auction, they get burnt. That is precisely what happened last week - at an estimated cost to market-makers of pounds 25m. The Government has broken almost every other rule of sound market practice over the past 18 months, I guess, so why not this one?
Rubbish, says the Bank. Interest rate cuts have been in the air for weeks, and there is no rule or understanding, written or unwritten, barring the Government from cutting rates ahead of an auction. Market-makers could have hedged their positions but chose not to, no doubt out of greed.
The truth, I suspect, lies somewhere between these two versions. The Bank of England must have warned ministers that the City would be deeply unhappy about a rate cut ahead of a big auction. It would have been failing in its responsibilities had it not. Ministers ignored the warning at their peril.
The Government will need all the help it can get in funding a borrowing requirement of about pounds 1bn a week next financial year. This little fiasco has hardly got it off on the right foot.Reuse content